The Cash Impact of Product Warranties
Reliable Appliances, a leading manufacturer of washing
machines and dryers, acquired a marginal competitor, Quality-Built, which had
been losing money during the past several years. To help minimize losses,
Quality-Built reduced its quality-control expenditures and began to purchase
cheaper parts. Quality-Built knew that this would hurt business in the long
run, but it was more focused on improving its current financial performance to
increase the firm’s prospects for eventual sale. Reliable Appliances saw an
acquisition of the competitor as a way of obtaining market share quickly at a
time when Quality-Built’s market value was the lowest in 3 years. The sale was
completed quickly at a very small premium to the current market price.
Quality-Built had been selling its appliances with a standard industry 3-year
warranty. Claims for the types of appliances sold tended to increase gradually
as the appliance aged. Quality-Built’s warranty claims’ history was in line
with the industry experience and did not appear to be a cause for alarm. Not
surprisingly, in view of Quality-Built’s cutback in quality-control practices
and downgrading of purchased parts, warranty claims began to escalate sharply
within 12 months of Reliable Appliances’s acquisition of Quality-Built. Over
the next several years, Reliable Appliances paid out $15 million in warranty
claims. The intangible damage may have been much higher because Reliable
Appliances’s reputation had been damaged in the marketplace.
Case Study Discussion Questions
1. Should Reliable Appliances have been able to anticipate
this problem from its due diligence of Quality-Built? Explain how this might
have been accomplished.
2. How could Reliable have protected itself from the
outstanding warranty claims in the agreement of purchase and sale?